Weekly Wrap-Up June 7-11, 1999

The North American bond markets fell under the weight of expected Fed action this past week, as investors continued to price in at least a 50 basis point rate hike. Investors are doing the Feds job for it, as money leaves the market or stays sidelined waiting for more stability, thereby pushing rates higher. This activity is very similar to the markets' reaction to the Feds shift to a tightening bias in 1996. The Canadian bond market outperformed on the perception that the Bank of Canada has more latitude with respect to rate hikes as inflation is less of a concern, and employment continues to be sticky. The equity markets headed south all week as concerns over interest rate increases dampened investors perceptions of potential future earnings. The financial services sector and the high-tech-dot-coms were knocked back on the week, dragging the markets lower. Canada managed to outperform the US as base metals and other commodity based industries benefitted from the strong economic growth in North America, and the perception of recovery in Japan.

The North American bond markets fell under the weight of expected Fed action this past week, as investors continued to price in at least a 50 basis point rate hike. Investors are doing the Feds job for it, as money leaves the market or stays sidelined waiting for more stability, thereby pushing rates higher. This activity is very similar to the markets reaction to the Feds shift to a tightening bias in 1996. At that time only two rate hikes occurred, however the market had priced in an entire rate hike cycle. The same is true now. The Canadian bond market outperformed on the perception that the Bank of Canada has more latitude with respect to rate hikes as inflation is less of a concern, and employment continues to be sticky.

The Federal Reserve Board meets June 29-30, 1999, to discuss the monetary conditions in the United States. Two of the Reserve Board's regional governors spoke over the course of the week. Both governors presented the market with indications that the Fed will raise rates at the next meeting, taking back some of the liquidity it provided the international markets during the meltdown in the fall of 1998. St. Louis Federal Reserve President Poole indicated that the markets were doing the Feds work for it. Fed Governor Braudus indicated the the last set of economic data were disturbing. Both Fed officials are hinting at the direction of the next Fed move - higher.

Good news out of Japan as the country reported a higher than expected 1.9% increase in first quarter GDP. Almost all of the growth came from public spending on infrastructure projects. Government spending is dragging the Japanese economy out of its doldrums, for now. It is widely expected that with the continuing corporate restructuring, that more job losses will occur, thereby placing a drag on the Japanese governments spending projects. Many economists believe that the second quarter data will show a reversal of some of the gains posted in the first quarter.

The Bank of England surprised many market participants this week, as it cut interest rates 25 basis points to 5%. Surprise came due to the fact that the Bank of England has now cut interest rates 7 times in the last 9 months in an effort to rebot the economy of the British Isles. Sluggish growth in Britain combined with a slowing economy on the European continent pushed the Bank to act.

Economic data released on both sides of the border indicated a strong economy, playing into the markets perception of the Feds next move. In the US, retail sales rose 1.0% in May, up 0.5% ex-autos; wholesale prices rose 0.2%; PPI rose 0.2%, with the core rate up 0.1%. In Canada, housing starts dropped 1.2% month-over-month; first quarter GDP rose 4.2%; the current account deficit dropped to $CDA 5.4 billion. The Canadian current account deficit was far better than market expectations, which had targeted the deficit between $CDA 15 -24 billion, which has been the range over the past six quarters.

The bond markets continue to be technically weak. Long bond rates in the US have risen through 6%, with technicians targeting 6.25% as the next support level for the market. Investors are concerned about the amount of corporate supply coming down the pipe. The belief is that the issuers would like to get their financing done ahead of September-October so they do not have to worry about liquidity concerns surrounding the Y2K issue. Canada outperformed the US market on the strength of the GDP data and current account numbers, as the US market is doing a great job doing the Feds job for it. The Bank of Canada issued $CDA 3.5 billion 2 year bonds this week, which were well received due to the perceived flexibility the Bank has with respect to interest rates. Many believe that the Bank of Canada will not have to match a rate hike by the Fed.

The Government of Canada 30 year long bond added 9 basis points over the week to close with a yield of 5.77%. The US Treasury 30 year long bond added 17 basis points to close the week yielding 6.14%. The Canada/US long bond spread is now at its narrowest close, -37 basis points. (A basis point is 1/100th of a percent.)

The North American equity markets headed south all week as concerns over interest rate increases dampened investors perceptions of future earnings potential. The financial services sector and the high-tech-dot-coms were knocked back on the week, dragging the markets lower. Canada managed to outperform the US as base metals and other commodity based industries benefitted from the strong economic growth in North America, and the perception of recovery in Japan.

US merger activity helped at the outset of the week, but concerns over the upcoming Fed meeting hurt US equities. The DJIA lost 309.33 points, or 2.86%, to close the week at 10,490.51. This leaves the big board up 14.26% on the year, but 4.90% off its highs. The S&P500 lost 2.57%, leaving it up 5.24% on the year but down 5.07% from its recent highs. The Nasdaq lost 1.23% on the week, leaving it up 11.64% year-to-date, but down 7.70% from its highs. The TSE closed down 23.01 points, or 0.33%, to close the week at 6917.13. Toronto benefitted from the strong Canadian GDP figure and the stronger than expected current account deficit.

Next week brings US CPI, housing starts, capacity utilization, industrial production and a couple of speeches by Federal Reserve Board Chairman Alan Greenspan. Most market participants will be watching the speech on Thursday for its market implications. Canadian CPI will also be released this week. All eyes are on US CPI and Fed Chairman Greenspan this week. Good trading.

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